Will E-commerce Companies Finally Start Making Profits in 2013?

The coming year could see the winners of the e-commerce industry emerge

T

here has been a lot of momentum behind e-commerce businesses in India over the past two years. In terms of investments, the sector has had a roller-coaster ride from very high valuations to what can now be called muted interest. I explore some of the key challenges Indian e-commerce players will need to navigate in 2013.

The Profitability ChallengeThere has been a fair degree of focus around profitability in e-commerce ventures over the past few months. There are different ‘levels’ of profit in the consumer internet space. At the first level, are you selling products for more than what you’re buying them for? Till last year that was a problem because many e-commerce companies were buying products at, say, Rs 1,000 and selling them for less. Thankfully, that has mostly disappeared this year.

At the second level is the gross margin: Are you selling products for more than the sum of the cost of goods, discounts, payment gateway costs, delivery and logistics expenses, returns costs, and any direct order costs (like a call centre to fulfil the orders)? Most Indian firms are still negative on gross margin. In 2013, I am expecting many of the e-commerce businesses to not just turn gross-margin-positive, but take it to a 10 percent level or more.

At the third level, are you able to amortise the cost of acquiring each new customer over his or her lifetime? For instance, if you acquired a customer for Rs 500, can you recover the amount in 12 to 18 months? Gaining unit customer profitability is the real objective companies should aspire for in 2013. This would demonstrate that there is a business model that works.

The final level is to get to positive EBITDA (earnings before interest, taxes, depreciation and amortisation) margins. I don’t think that will happen in the next two to three years because companies will continue to invest in growth—for example, continue to acquire customers even though it takes them 12 to 18 months to break even. In fact, if some do get EBITDA-positive, I would think they are probably under-investing!

Most e-commerce companies report on each of these four levels in a different manner, so it’s not easy to compare them. And while not much has changed in their behaviour from 12 months ago, something else has: They are running out of cash.

The Financing ChallengeThe financing environment in e-commerce has changed completely, so much so that in the last nine months we haven’t seen a single significant instance of external financing. By that I refer to a funding of at least $10-15 million by an ‘outside investor’. Companies are coming into the financing market and are not being able to raise money.

The potential of e-commerce businesses to raise public money is not clear. If one buys the argument that Indian e-commerce firms won’t be profitable in India in the next few years, then they effectively can’t do an IPO in India. That largely leaves Nasdaq, but I am not sure how enthusiastic investors there will be for a loss-making company in India, especially after the experience global investors have had with Chinese e-commerce companies.

If entrepreneurs felt China was the ‘closest’ comparison to India, the worrying part is that most Chinese e-commerce businesses have yet to make profits. Till May 2011, these businesses were still going public on the NYSE and Nasdaq. But once that music stopped, global investors have been wary of investing in firms with no clear path to profitability. India has to demonstrate its own path to value creation.

As a result of the financing crunch, there will be companies that can’t survive and will therefore need to merge or shut down. Companies with strong investor syndicates around them may be able to navigate this challenge better.

The Differentiation ChallengeAmong players in India, the notion of differentiation to the consumer is yet to be established. E-commerce largely remains a play when one service is indistinguishable from another. Players in categories like home furnishing, baby products or apparel, haven’t managed to create a differentiated consumer offering.

There could be varied bases for such differentiation—merchandising, customer experience, delivery efficiency and supply chain are some of them—and I would expect firms to focus on differentiation in 2013. The notion of differentiation and capital raising is dependent on competition in a category, and the ability to survive could be the ultimate advantage. This is a self-balancing system and I won’t be surprised if there is a shake-out in the next 12 months, and the ‘last men standing’ attract consumer mindshare and capital.

Light at the End of the TunnelThere has been positive progress towards the above objectives. Overall discount levels have dropped. More e-commerce companies stock and own less inventory in favour of a marketplace-based fulfilment model. The fall in competitive aggression has brought down the cost of customer acquisition by 20-30 percent. Investor syndicates have held up, and are backing their winners. Topline growth is on track, with most leading players closing two to three times growth over last year. I am confident that 2013 will separate the boys from the men, and the industry will produce winners, thereby rewarding efforts of early believers in the opportunity.

(As told to Rohin Dharmakumar)

Alok Mittal is the managing director at Canaan India. Prior to joining the venture industry, Alok co-founded JobsAhead.com, which was acquired by Monster.com. He is also co-founder of Indian Angel Network, is on the board of TiE (The Indus Entrepreneurs) in Delhi and is an advisor to Adtech India.

This article appeared in the Forbes India magazine issue of 11 January, 2013

Profitability, though an important parameter, is probably a critical component for e-commerce sites which are not in the big league and need money to sustain their business. Top players like flipkart have again and again stressed that profitability for them is not difficult but the focus is to be an industry leader and sacrifice profitability in the short term. And investors seem to be into this philosophy, which might justify an acquisition of the a company like Myntra.

The biggest mistake all entrepreneurs, especially those from abroad, make in India is that they have still not studied the customer properly. Indians are the most complex customers I have ever come across. And social media to an Indian customer is simply equal to 'free mein kya milega'. There is no question of loyalty from 99.99% of our society. Or seriousness. And India does not even have a middle class from this point of view. The so called middle class is still stuck in their most basic expenses of roti, kapda and maakan. The Indian customer may have a smart phone or a nice pair of shoes, but he is always waiting for a free meal or a gift from his team leader or on some ceremony or marriage function - including free corporate trips (which they then call as a holiday even though it was nothing close). THEY HAVE NO SPENDING POWER.

I am glad that you have highlighted 'unit customer profitability' as an important parameter.

Unit level economics is central to any business and e-Commerce is no different. Unfortunately, over last few years entrepreneurs and investors have chosen to ignore this. Even today, Flipkart/Jabong/Snapdeal considers it wise to deliver my Rs 1,000 COD order comprising 4 items, in 4 parts, one item at a time within a short span of 2 days. I hope that sanity will prevail very soon.

I like your pragmatism when you say, "I am confident that 2013 will separate the boys from the men, and the industry will produce winners, thereby rewarding efforts of early believers in the opportunity". I only hope that winners-to-be are chosen based on sound business rationale and the financing ecosystem supports the right players.

I totally agree.. the big players including some of the new players also are trying to acquire the customers by selling their products at a loss. But the main point of discussion is are Indian customers faithful or loyal to their respective shopping sites. The answer is clear

I was looking forward to your insights, but this disappointed. You mention most e-commerce companies will expand their gross margins this year (as I understand between -14 to -3%) to 10%. How will this happen? Hiking prices is not feasible. So this must come out of SCM - do you see any of the e-tailers commanding discounts from suppliers, or see the delivery eco-system getting more efficient? Or is it a drop in inventory which will also result in delayed/erratic delivery, pushing customers back to brick and mortar stores.

2. You mention that e-commerce is unable to differentiate themselves. From what? It's a fledgling industry catering mostly to urban customers, and yet limited by internet penetration, dispute resolution and trust issues. In my view, it's too early for differentiation till underlying factors and hence the business models mature. Maybe 3 years down the road

3. The real opportunity e-tailers have in India, in my view, is creation of an extremely customer-centric platform compared to brick and mortar shops. Flipkart

Manoj - we are seeing many ecommerce companies at the cusp of gross margin break even, i.e. 0-5% negative. The key efficiencies will build up in (a) sourcing getting more efficient - part of it may require more stocking rather than less; (b) delivery efficiencies. Much of this is scale related.

Differentiation challenge largely exists from a consumer viewpoint, relative to offline and other online retail. The big proposition online so far has been price - leading players are beginning to drive convenience. At the next stage, promises of availability need to be delivered. Branding differentiation, customer experience, and supply chain integration are other key potential areas.

Hi,
I don't see any value add from your article .The things you mentioned are so obvious that any one reading few article on ecommerce industry would be able to make. I had expected some really good insight in terms of numbers as to change in working of ecommerece industry vis-a-vis last years in terms of their discount model, delivery system, category focus, operational efficiency. This funda of 'last man standing" this is so much in the ecommerce article that I am forced to think if every one else is other than flipkart is fool because that what every one this is the last man . But, I am sure there are lot more intelligent business people who will make sense with their business even in ecommerce sector. Please write good articles.

As a consumer, i think there is a differentiated challenge prevailing in e-commerce As regards to customer experience while shopping, i think 3D virtual online shopping stores can help maximising the online shopping experience of the customer giving him a feeling of really being @marketplace .

Profitability, though an important parameter, is probably a critical component for e-commerce sites which are not in the big league and need money to sustain their business. Top players like flipkart have again and again stressed that profitability for them is not difficult but the focus is to be an industry leader and sacrifice profitability in the short term. And investors seem to be into this philosophy, which might justify an acquisition of the a company like Myntra.
But for smaller sized e-commerce site, not working to ensure profitability might lead to issues in surviving and finally having to close down operations as many known e-commerce sites had to do in the past. (See: http://www.klypy.com/in/ecommerce-shut-downs-acquisitions-india/)
So, though profitability is important but it is dependent on the state of the business and their short term and long term goals along with the kind of backing they have from investors.

The biggest mistake all entrepreneurs, especially those from abroad, make in India is that they have still not studied the customer properly. Indians are the most complex customers I have ever come across. And social media to an Indian customer is simply equal to 'free mein kya milega'. There is no question of loyalty from 99.99% of our society. Or seriousness. And India does not even have a middle class from this point of view. The so called middle class is still stuck in their most basic expenses of roti, kapda and maakan. The Indian customer may have a smart phone or a nice pair of shoes, but he is always waiting for a free meal or a gift from his team leader or on some ceremony or marriage function - including free corporate trips (which they then call as a holiday even though it was nothing close). THEY HAVE NO SPENDING POWER.